Why 2005 Will Be Good for the Stock Market

In recent days I've received forwarded e-mails of an article that evidently
has been circulating the Internet. It pertains to an in-depth study of year
ending in 5. In it, the author tries to establish that the past century's unbroken
record of bullish X-5 years in each decade can be explained away in most cases
as pertaining to either "chance" or had to do with U.S. presidential policy.

I found this author's attempt at dissecting the Year 5 Phenomenon and his
conclusion that 2005 will be the exception to this rule, while obviously well-researched,
somewhat lacking. He seemed intent on proving that the remarkable and unbroken
string of bullish X-5 years is not attributable to any long-term cycle or wave,
but rather mere happenstance or the result of political maneuvering. He even
called the exceptional stock market gains of 1925, 1945, 1965, and 1985 mere "chance," a
dismissal that cannot be overlooked.

The author states that the years 1935, 1955, 1975 and 1995 were "predictably
good years," and attributes the positive performance of these years to incumbent
U.S. presidents wanting to be re-elected. He writes, "Accordingly, just after
the U.S. mid term election near the end of the second year of his mandate,
he introduces and supports fiscal stimulus to improve the economy by the fourth
year of his mandate. Historically, U.S. equity markets have recorded their
best year of performance in the four year cycle during the third year of a
president's mandate in anticipation of strong earnings gains into the fourth
year."

How much of the economic strength of the third year of a president's term
can be attributable to his fiscal policy is debatable. What isn't debatable
is that in the most recent X-3 year, the excellent stock market gains of 2003
were mainly attributable to the bottoming of the 12-year cycle in late 2002.
This leads me to the main consideration behind the Year 5 Phenomenon. The 10-year
cycle always bottoms in the fourth year of each and every decade. As those
of you who have read my work this year know, the 10-year cycle was due to bottom
this year and has already done so. It is this lifting of pressure from a major
long-term cycle that clears the way for the market to rally in the X-5 year,
hence, every fifth year of the decade has been bullish because the downside
pressure of the 10-year cycle has lifted.

In his book, Don't Sell Stocks on Monday, Yale Hirsch showed that the middle
year of the decade has produced a rather sizeable rally in the stock market
in 11 out of 11 times, making it the strongest year in the so-called Decennial
Pattern. Years ending in five from 1885 through 1995 have produced an average
gain of over 25%! Hirsch has chronicled that the fifth years of the decade
is where the vast majority of profits are made. He showed a total gain of 254
percent in the X-5 years, making these years among the very best of each decade.

If you are a stock market bear, ask yourself this question: "Do I really believe
that with the alleviation of pressure from the Kress 12-year and 10-year cycles,
and with past performance as an untenable guide, that 2005 will be any different
than other X-5 years?" If you answered "yes" to that question then you are
simply betting against history and you will most likely lose that bet.

Returning to the study, the author makes the following conclusion: "Chances
are 2005 will be a difficult year for U.S. equity markets." Among other reasons
for making this assumption, the author provides the following possible scenarios
for the coming year:

* "The Federal Reserve's attempt to "sop up" excess liquidity in a systematic
way by raising interest rates."

Response: The Fed recently raised the Federal funds overnight lending rate
from 1.5 percent to 1.75 percent. Coming off 45-year lows, "raising" the interest
rate in a systematic way isn't necessarily going to upset the upward path of
equity markets as long as those rate increases are in line with the natural
rate of interest, which are not likely rise to dangerous levels in the next
10 years. The K-wave hasn't even bottomed yet, yet alone the 120-year cycle,
which means the rate of interest is likely to remain at reasonably low levels
for the remainder of this decade. The stock market has in all likelihood already
discounted Fed rate increases in the foreseeable future. In fact, one could
make a case that the lateral correction of 2004 was the market responding in
advance to these coming increases.

* "Declining consumer confidence due to record high debt levels."

Response: Since when has a decline in consumer confidence ever been attributable
to high debt levels? Consumers are quite happy to remain in debt up to their
eyeballs as long as they can convince themselves that they can remain financially
afloat and can continue to borrow and make payments on existing debt. America
is a debt-based consumer economy. As perverse as it may be, the more debt there
is the greater the economy will expand, and along with it, consumer confidence
levels. Consumer confidence levels are mainly a function of the rate of change
in the available money supply. Consumer confidence falls in response to declines
in the money supply but rises in response to "easy money." The increase in
money supply of recent months will eventually hit the economy by early 2005
and when it does consumers will suddenly regain their "lost" confidence.

As an aside, it was recently reported that U.S. household assets rose to a
record $56 trillion while their liabilities rose to $10 trillion. That's a
net worth of $46 trillion as of mid-year! Economist Dr. Ed Yardeni points out
nearly ten percent of household net worth was in very liquid time and savings
deposits -- a record $4.1 trillion. "Americans do have a lot of debt," writes
Yardeni, "but 70 percent of it is in home mortgages, which have become less
burdensome for many homeowners, since they refinanced at lower and lower mortgage
rates."

Does this picture look like the "cash-strapped consumer" that many bearish
analysts are painting to you? These liquidity figures speak volumes about the
true underlying state (near-term) of the U.S. economy.

* "Declining confidence in the U.S. dollar by international investors."

I've said it before and I'll say it again. The feds will not allow the dollar
to break below its long-term benchmark support. The process of global economic
integration, which is being led by the U.S., depends in large measure upon
the "dollarization" process. Until the globalization process is complete the
dollar will not be allowed to collapse and thus will be bolstered during critical
periods. The U.S. market Enforcers have ways of making domestic markets look
attractive to overseas investors when needed.

One very vital bullet point that most bearish commentators seem to miss is
the impact of globalization on the free markets of developed countries, including
the U.S. As Donald Rowe of the Wall Street Digest recently remarked, "Thanks
to free trade, free markets and global competition, there is an abundance of
virtually everything. Hence, inflation is not going to erupt and interest rates
are likely to remain low for the rest of the decade."

And with record inflows of foreign imports coming into our shores each year,
the consumer-based U.S. economy will likely remain liquified by the Enforcers
so that consumers can buy these goods to keep the global economy propped up
long enough for the integration process to be completed.

Clif Droke is a recognized authority on moving averages and internal
momentum. He is the editor of the Momentum Strategies Report newsletter,
published since 1997. He has also authored numerous books covering the fields
of economics and financial market analysis. His latest book is Mastering
Moving Averages. For more information visit www.clifdroke.com